Libor Scandal Is No Match for Its Medieval Precedent

July 27 (Bloomberg) -- The financial news has recently been
dominated by the scandal over the London interbank offered rate
(known as Libor), with allegations that leading banks have
manipulated a financial benchmark determining the interest rates
charged to millions of borrowers and used in derivatives
contracts worth hundreds of trillions of dollars.

The U.K. Parliament has become involved, grilling the
former chief executive officer of Barclays Plc, Bob Diamond,
over these events. But none of this is entirely without
precedent.

A new study of the foreign-exchange market in the Middle
Ages, conducted by the University of Reading’s ICMA Centre, has
documented a medieval system of exchange-rate manipulation
similar to today’s.

That system also led to public outcry, a parliamentary
investigation and the impeachment of a famous financier.

A major aim of financial innovation throughout history has
been to circumvent regulations and restrictions placed on the
industry. In the Middle Ages, an important obstacle was the
religious disapproval of usury -- the charging of interest or
“making money from money.” Dante condemned the usurer to the
lowest level of the seventh circle of Hell. To avoid the “taint
of usury,” medieval financiers developed various methods of
disguising interest within other transactions.

Voluntary Gift

The simplest method was for the borrower to recognize a
debt of 15 pounds when he had borrowed only 10, the 5 pound
difference being the lender’s profit. Or the borrower could pay
the lender a “voluntary” gift on top of the principal.
Alternatively, the lender could impose a penalty in case of
“late” repayment, where the loan was deliberately intended to be
repaid late.

Another medieval practice that might resonate today was
“chevisance,” or in modern parlance, a repurchase arrangement.
Here, a borrower would sell goods to the lender at one price
with the understanding that the borrower would buy them back at
a higher price. This is similar to our contemporary repo market,
which underpins the shadow banking system.

Perhaps the most sophisticated method of disguising usury
involved foreign-exchange transactions. The pound sterling, for
example, was always valued higher in Venice than in London.
These differentials (or spreads) enabled bankers to profit by
moving money from one place to another and back.

To produce and maintain these spreads, however, required
systematic “rigging” of exchange rates across Europe. In
essence, banks and currency brokers in London always had to
deduct a few pence from the rate with Venice, and their
counterparts in Venice had to add a few pence.

But was this wrong? Without these exchange-rate
adjustments, it would have been much more difficult to profit
from foreign-exchange transactions. There would have been no
incentive for medieval bankers to engage in the foreign-exchange
market, which would have reduced the ability of merchants to
fund their trading ventures or to transfer money
internationally. Similarly, without the methods described above
to disguise interest payments, there could have been no credit
market. Although such techniques may have been essential for the
functioning of medieval finance, and perhaps came to be viewed
as normal business practice to those involved, the wider public
was less understanding.

During the “Good Parliament” of 1376, public discontent
over such perceived financial abuses came to a head. The
Commons, represented by the speaker, Peter de la Mare, accused
leading members of the royal court of abusing their position to
profit from public funds.

Foreign Exchange

A particular target was the London financier Richard Lyons,
an immigrant from Flanders who had risen to become one of the
wealthiest and most influential citizens, partly through his own
talents as a merchant but also by capitalizing on his personal
connections to members of the court. Among other crimes, Lyons
was suspected of imposing an unauthorized tax on foreign-exchange transactions and overcharging the king for loans. On
one occasion, he and William Lord Latimer were said to have
arranged a loan of 20,000 marks for the king but charged him
30,000 marks, a usurious rate of interest.

Initially the government bowed to public pressure. Lyons
was imprisoned in the Tower of London and his properties and
wealth were confiscated. Other leading courtiers implicated in
these abuses, such as Latimer and the king’s mistress, Alice
Perrers, were banished from court.

Once parliament had dissolved and the public outcry had
died down, however, the king’s eldest son, John of Gaunt, acted
to reverse the verdicts of the Good Parliament. Latimer and
Perrers soon reappeared at the king’s side and Lyons was
released from the Tower and recovered his wealth, while the
“whistleblower” de la Mare was thrown in jail. The government
also sought to appease the wealthy knights and merchants that
dominated parliament by imposing a new, regressive form of
taxation, a poll tax paid by everyone rather than a tax levied
on goods. This effectively passed the burden of royal finance
down to the peasantry.

It seemed as though everything had returned to business as
normal and Lyons appeared to have gotten away with it. In 1381,
however, simmering discontent over continuing suspicions of
government corruption and the poll tax contributed to a massive
popular uprising, the Peasants’ Revolt, during which leading
government ministers, including Simon of Sudbury (the chancellor
and archbishop of Canterbury) and Robert Hales (the treasurer)
were executed by the rebels. This time, Lyons did not escape; he
was singled out, dragged from his house and beheaded in the
street.

Political Uncertainty

Although certain forms of financial engineering play a
vital role within the economic system, when viewed from outside,
they may seem amoral or even illegal. In this way, revelations
about the hiding of usury in the Middle Ages or the fixing of
Libor both reflect and contribute to a wider public suspicion of
finance. It is particularly dangerous when such financial
scandals coincide with periods of wider economic and political
uncertainty, as in the 1370s and today.

The question now is whether public outrage at the Libor
scandal and other financial misdeeds will lead to fundamental
reforms of the financial sector -- such as the separation of
retail and investment banking or legislation to regulate the
“bonus culture” -- or just more cosmetic changes that fail to
address the structural issues.

Will we have to wait for a 21st century peasants’ revolt
before seeing any real change?

(Adrian R. Bell is a professor of the history of finance,
Chris Brooks is a professor of finance and Tony K. Moore is a
research assistant at the ICMA Centre, Henley Business School,
University of Reading.)